Boosted inflation – using machine learning to make sense of non-linear determinants of inflation

Marcus Buckmann, Galina Potjagailo and Philip Schnattinger

Disentangling the sources of high inflation, exceeding inflation targets in the post- pandemic period, has been a priority for monetary policy makers. We use machine learning for this task – a boosted decision tree model that fits non-linear associations between many indicators and inflation. We add economic interpretability by categorising the data into intuitive blocks representing components of the Phillips curve. To further disentangle inflation drivers, we separate the signals that reflect demand and supply by imposing sign-restrictions on the decision trees. Our model tells us that both global supply and domestic demand spurred UK CPI inflation post-pandemic. We detect important non-linearities: in the Phillips curve relationship with labour market tightness and unemployment and via additional effects from short-term inflation expectations.

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Fossicking in the dark or twenty-twenty foresight?

Rishi Khiroya and Lydia Henning

If you asked people what skill they would most love to have, you might receive answers like ‘to fly’, ‘to be invisible’ or even ‘predicting the future’. If you asked people who worked in financial markets in particular, ‘accurately predicting the future’ would probably be top of the list. From economic trends to political shifts, market participants have a stake in anticipating what comes next. We use data collected from the Bank’s Market Participants Survey (MaPS) to see how market predictions have tended to compare with what subsequently unfolds over the period of high uncertainty and volatility that has been observed in the wake of the pandemic – and how predictive accuracy has varied depending on the time horizon in question.

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Weathering the storm: the economic impact of floods and the role of adaptation

Rebecca Mari and Matteo Ficarra.

Floods are the most costly natural disaster in Europe. In the UK, they account for around GBP1.4 billion in annual losses. Yet, evidence on the macroeconomic implications is inconclusive. GDP often shows a puzzling delayed response, and prices can be pushed in opposite directions. Using a novel county level data set for England for the years 1998–2021, we estimate the impact of flooding on output and inflation at the sector level. Sectors react heterogeneously to floods, which explains well aggregate evidence. Prices respond in sectors related to both headline and core inflation, which has crucial implications for monetary policy. We further show that investing in flood defences mitigates the economic burden of floods by strongly reducing the risk of flooding.

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Some implications of climate policy for monetary policy

Francesca Diluiso, Boromeus Wanengkirtyo and Jenny Chan.

This post examines key aspects of climate mitigation policies that could matter for monetary policy, using insights from structural climate macroeconomic models (Environmental Dynamic Stochastic General Equilibrium). Three main findings emerge: first, mitigation policies – like carbon pricing – can be a direct source of shocks, creating potential trade-offs for monetary policy (Carney (2017)). Second, the degree to which these policies are anticipated affects their macroeconomic impacts. Third, different climate policies may alter the transmission of conventional business-cycle shocks, therefore affecting the calibration of optimal monetary policy. We focus on the 3–5 year horizon, abstracting from longer-run considerations and changing trends such as interactions with the zero lower bound, the natural interest rate, or transitional effects on productivity and output.

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The transmission channels of geopolitical risk

Samuel Smith and Marco Pinchetti

Recent events in the Middle East, as well as Russia’s invasion of Ukraine, have sparked renewed interest in the consequences of geopolitical tensions for global economic developments. In this post, we argue that geopolitical risk (GPR) can transmit via two separate and intrinsically different channels: (i) a deflationary macro channel, and (ii) an inflationary energy channel. We then use a Bayesian vector autoregression (BVAR) framework to evaluate these channels empirically. Our estimates suggest that GPR shocks can place downward or upward pressure on advanced economy price levels depending on which of the two channels the shock propagates through.

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Markup matters: monetary policy works through aspirations

Tim Willems and Rick van der Ploeg

Since the post-Covid rise in inflation has been accompanied by strong wage growth, interactions between wage and price-setters, each wishing to attain a certain markup, have regained prominence. In our recently published Staff Working Paper, we ask how monetary policy should be conducted amid, what has been referred to as, a ‘battle of the markups’. We find that countercyclicality in aspired price markups (‘sellers’ inflation’) calls for more dovish monetary policy. Empirically, we however find markups to be procyclical for most countries, in which case tighter monetary policy is the appropriate response to above-target inflation.

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CPI-weighted wage growth

Josh Martin

The Monetary Policy Committee has recently looked at wage growth as an important indicator of inflation persistence. One way that wages matter for price inflation is as a cost for businesses, who may raise their prices in response to higher wages. For this channel, the wage measure needs to reflect the coverage and composition of the Consumer Prices Index (CPI). However, most wage measures do not. This blog explores a wage growth measure which is re-weighted to better match the CPI.

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Beyond the average: patterns in UK price data at the micro level

Lennart Brandt, Natalie Burr and Krisztian Gado

The Bank of England has a 2% annual inflation rate target in the ONS’ consumer prices index. But looking at its 700 item categories, we find that very few prices ever change by 2%. In fact, on a month-on-month basis, only about one fifth of prices change at all. Instead, we observe what economists call ‘sticky prices’: the price of an item will remain fixed for an extended amount of time and then adjust in one large step. We document the time-varying nature of stickiness by looking at the share of price changes and their distribution in the UK microdata. We find a visible discontinuity in price-setting in the first quarter of 2022, which has only partially unwound.

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Profits in a time of inflation: what do company accounts say in the UK and euro area?

Gabija Zemaityte and Danny Walker

Inflation has been high in many countries since 2021. Some have said that companies have increased their profits over that period: so-called ‘greedflation’. We use published company accounts for thousands of large listed companies to look for signs of increased profits in the data. Consistent with previous analysis of aggregate incomes, price indices and business surveys, we find no evidence of a rise in overall profits in the UK – prices have gone up alongside wages, salaries and other input costs. Companies in the euro area are in a similar position. However, companies in the oil, gas and mining sectors have bucked the trend, and there is lots of variation within sectors too – some companies have been much more profitable than others.

Recent analysis by Sophie Piton, Ivan Yotzov and Ed Manuel has shown that corporate profits have been relatively stable in the UK and that profits are unlikely to have been a big contributor to inflation. Others have suggested that the trend in the euro area has been somewhat different. In this post we use a novel data source to look at this question: the information companies have reported in their accounts.

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Has the import price shock been worse in the UK or euro area?

Josh Martin and Julian Reynolds

How much have higher import prices increased consumer prices in the UK and euro area? This post explores this question using a framework grounded in some fundamental economic and national accounting concepts. Starting with the GDP price, we adjust for relative import and export prices to arrive at a consumer prices measure – this gives us a sense of the impact of import prices and the terms of trade shock on consumer price inflation. For the euro area, aggregating imports across member countries, which includes trade between members, risks overstating total imports and thus the effect on inflation. Using supplementary data to resolve this issue, we find that the euro area terms of trade shock has been larger than the UK’s.

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